Retirement Provision in Scary Markets For Bruce, Elizabeth, Nicholas and Thomas Retirement Provision in Scary Markets Edited by Hazel Bateman Deputy Director, Centre for Pensions and Superannuation and Senior Lecturer, School of Economics, Faculty of Commerce and Economics, University of New South Wales, Australia Edward Elgar Cheltenham, UK • Northampton, MA, USA © Hazel Bateman 2007 All rights reserved No part of this publication may be reproduced, stored in a retrieval system or transmitted in any form or by any means, electronic, mechanical or photocopying, recording, or otherwise without the prior permission of the publisher Published by Edward Elgar Publishing Limited Glensanda House Montpellier Parade Cheltenham Glos GL50 1UA UK Edward Elgar Publishing, Inc William Pratt House Dewey Court Northampton Massachusetts 01060 USA A catalogue record for this book is available from the British Library Library of Congress Cataloguing-in-Publication Data Retirement provision in scary markets / [edited by] Hazel Bateman p cm Retirement provision in scary markets : introduction / Hazel Bateman – Who’s afraid of the big bad bear? or, why investment in equities for retirement is not scary and why investing without equities is scary / Ronald Bewley, Nick Ingram, Veronica Livera and Sheridan Thompson – Assessing the risks in global fixed interest portfolios / Geoffrey Brianton – The role of index funds in retirement asset allocation / David R Gallagher – Retirement wealth and lifetime earnings variability / Olivia S Mitchell, John W.R Phillips, Andrew Au and David McCarthy – How have older workers responded to scary markets / Jonathan Gardner and Mike Orszag – Financial engineering for Australian annuitants / Susan Thorp, Geoffrey Kingston and Hazel Bateman – Smoothing investment returns / Anthony Asher – Ansett’s superannuation fund : a case study in insolvency / Shauna Ferris – Pension funds and retirement benefits in a depressed economy : experience and challenges in Japan / Masaharu Usuki – The structure and regulation of the Brazilian private pension system / Flavio Marcilio Rabelo Includes bibliographical references and index Pension trusts–Management Stock exchanges Uncertainty Risk I Bateman, Hazel HD7105.4.R48 2006 331.25´2—dc22 2006002840 ISBN 978 84376 906 Typeset by Cambrian Typesetters, Camberley, Surrey Printed and bound in Great Britain by MPG Books Ltd, Bodmin, Cornwall Contents List of contributors Preface and acknowledgements 10 11 vi vii Introduction Hazel Bateman Who’s afraid of the big bad bear? Or, why investing in equities for retirement is not scary and why investing without equities is scary Ronald Bewley, Nick Ingram, Veronica Livera and Sheridan Thompson Assessing the risks in global fixed interest portfolios Geoffrey Brianton The role of index funds in retirement asset allocation David R Gallagher Retirement wealth and lifetime earnings variability Olivia S Mitchell, John W.R Phillips, Andrew Au and David McCarthy How have older workers responded to scary markets? Jonathan Gardner and Mike Orszag Financial engineering for Australian annuitants Susan Thorp, Geoffrey Kingston and Hazel Bateman Smoothing investment returns Anthony Asher Ansett’s superannuation fund: a case study in insolvency Shauna Ferris Pension funds and retirement benefits in a depressed economy: experience and challenges in Japan Masaharu Usuki The structure and regulation of the Brazilian private pension system Flávio Marcílio Rabelo Index 14 45 55 78 100 123 145 161 187 211 237 v Contributors Anthony Asher, Australian Prudential Regulation Authority, Sydney Andrew Au, University of Pennsylvania, Philadelphia Hazel Bateman, The University of New South Wales, Sydney Ronald Bewley, Commonwealth Securities, Sydney Geoffrey Brianton, Merrill Lynch Investment Managers, Melbourne Shauna Ferris, Macquarie University, Sydney David R Gallagher, The University of New South Wales, Sydney Jonathan Gardner, Watson Wyatt LLP, Surrey, UK Nick Ingram, Commonwealth Securities, Sydney Geoffrey Kingston, The University of New South Wales, Sydney Veronica Livera, Commonwealth Securities, Sydney David McCarthy, Imperial College, London Olivia S Mitchell, Pension Research Council, Wharton Business School, University of Pennsylvania, Philadelphia Mike Orszag, Watson Wyatt LLP, Surrey, UK John W.R Phillips, Social Security Administration, Washington, DC, USA Flávio Marcílio Rabelo, Escola de Administracao de Empresas de São Paulo Sheridan Thompson, Commonwealth Securities, Sydney Susan Thorp, University of Technology, Sydney Masaharu Usuki, NLI Research Institute, Tokyo vi Preface and acknowledgements This book was motivated by consideration of the economic, financial and social implications of the increasing reliance on funded private provision for retirement Most of the contributory chapters were workshopped at the conference ‘Retirement Provision in Scary Markets’ held in Sydney, Australia in July 2003 The successful staging of this conference, the tenth in a series of annual colloquia of superannuation researchers held in Australia, was due to the hard work and dedication of the academics and administrators associated with the Centre for Pensions and Superannuation at the University of New South Wales Special thanks must go to the Director of the Centre for Pensions and Superannuation, Professor John Piggott, for ongoing support and encouragement, as well as to Clea Bye for her excellent conference organization An edited volume such as this would not be possible without the hard work and cooperation of the contributory authors I would like to thank all of them for their overwhelming support, from initial planning through to the conference itself, and then the rewriting and editing required as the conference papers evolved into book chapters Acknowledgement must also be made to the conference discussants and participants, whose comments and suggestions helped to shape the final manuscript Nadine Caisley deserves special mention for reading the entire manuscript as it neared completion Finally, I would like to thank my family for their understanding and patience, particularly my daughter Elizabeth who provided unending moral support while preparing for her own HSC exams Hazel Bateman University of New South Wales, Sydney November 2005 vii Introduction Hazel Bateman Over the past few decades there has been a global move towards private provision for retirement through individual defined contribution plans, at the expense of publicly provided and employer-sponsored defined benefit arrangements As a consequence, workers and retirees are increasingly exposed to uncertainties in financial, economic and labour markets These uncertainties have materialized in the form of extreme stock price volatility, discontinuous labour market participation, regulatory failure and macroeconomic instability The broad aim of this book is to identify these potentially scary aspects of pre-funded private provision for retirement, relate specific country experiences and offer possible solutions Overall, private funded retirement income arrangements are seen to be resilient to a wide range of scary market scenarios RETIREMENT INCOME TRENDS AROUND THE WORLD In developed and less developed countries alike there is an ongoing trend towards greater emphasis on private retirement income arrangements In the developed world, this has been largely due to financing shortfalls associated with generous, less than fully funded, public pensions in the face of population ageing (OECD 2005a; Commission to Strengthen Social Security 2001; Feldstein 2005; Takayama 1998) Also important has been the goal to increase living standards of the elderly (Bateman and Piggott 1997) In the developing world the trend has been driven by a slightly different set of factors, including rapid industrialization or a desire to increase economic growth, combined with inadequate, low coverage or corrupt formal retirement income arrangements (World Bank 1994; Holzmann and Hinz 2005) Chile was the first country to make funded private arrangements the dominant form of retirement income provision when the pay-as-you-go (PAYG) public pension was ‘privatized’ in 1981 This marked the beginning of a trend which continues to this day Switzerland and Australia followed in the mid1980s, with the introduction of mandatory funded private arrangements to supplement their public pension schemes Voluntary participation in private 230 Retirement provision in scary markets The supervisory process and the transparency of the information could be enhanced if proper benchmarks were developed for each asset class and subclass The sub-classes for equity investments are rather confusing Further, the use of governance criteria for setting limits, though a good idea in practice, may generate an artificial market bubble, since very few Brazilian firms have a good rating in this area Improvements are also needed in regard to risk control and performance evaluation of pension fund investments One alternative is to place greater responsibility on the Board of Trustees, demanding that they produce a formal document stating that they are satisfied with the fund’s investment performance In this manner, more transparency would be obtained without the supervisory body having to demand more information from the pension funds A much-criticized issue is the establishment of different portfolio limits for defined benefit and defined contribution plans There is no technical background for introducing this differentiation and it should be abolished from the regulation Brazilian pension funds are still not allowed to make foreign investments The only exception is those funds that invest in Brazilian foreign sovereign debt bills It has been suggested that they be permitted to purchase ADRs of Brazilian companies and also foreign issues (debt) of Brazilian companies Beyond these more specific critiques of the current legislation, one can question the whole rationale of the regulation of occupational pension fund investments in Brazil The concept of quantitative portfolio restrictions and the requirement of monthly detailed reports on portfolio allocation not seem efficient Since mid-2002, pension funds have been required to send the SPC a detailed report describing the allocation of their portfolio This is simply a cost that produces no benefit since the SPC does not have the resources to analyse these reports properly And even if it had, the value of such short-term data to evaluate the soundness of a fund’s investment policy is questionable What the SPC needs is a risk evaluation model and a law defining the responsibilities and penalties for trustees, actuaries, auditors, accountants and investment managers There should be a duty on these agents to report unlawful behaviour What should be demanded from EFPCs is that they keep a reliable record of the investment decision-making process, to determine who took the decisions and how they were made One of the reasons that make it hard to punish pension fund managers and trustees is the difficulty of establishing clear personal responsibility for harmful investment decisions A large pension fund recently adopted a very sound policy to deal with this matter It established published guidelines that have to be followed in every investment decision, and a checklist of items to be observed by the decision makers In cases where the decision maker decides not to abide by a specific guideline, he (she) must state in writing the reasons for this departure The Brazilian private pension system 231 The open pension system Investment regulations in the open fund system differ according to the type of product and the period Traditional plans must abide by the asset class limitations and diversification requirements established by CMN Resolution No 2967 (31 May 2002) These limits, as can be observed in Table 11.7, are quite similar to those of the closed fund system One difference is that this regulation does not apply credit risk criteria for the limits of fixed income securities as is done for the closed funds There are also lower limits for equity investment The new plans (PGBL, PRGP, PAPG, VGBL, VRGP, VAGP) have to respect the ‘special conditions’ of the above-mentioned Resolution 2967 These conditions require that during the accumulation period, all the assets of these plans must be invested in a mutual fund (FIF) created specifically for this purpose They may also invest in a mutual fund that purchases quotas of these special FIFs, which is called a FAQ, although the use of this latter vehicle is still pending a circular from SUSEP The portfolio of these FIFs must comprise only assets as specified under Resolution 2967 and, except for the equity investment limits, respect the limits and conditions set by this Resolution This implies that these FIFs may not invest in real estate During the benefit payment period, if the annuity contracted includes the reversal of a portion of the excess return, the guaranteeing asset must obey these ‘special conditions’, otherwise they may be invested according to the general parameters set by Resolution 2967 All the new plans can be grouped in the three categories according to the portfolio composition of their FIF: sovereign, fixed income and mixed income A sovereign fund can only have government securities in its portfolio Fixed income funds are allowed to purchase private fixed income instruments, and mixed income funds can have in their portfolio any of the securities mentioned in Resolution 2967 The great advantage of this investment structure is its transparency and the assurance of better control over the assets and their pricing All FIFs are supervized by the Brazilian Central Bank and the Securities Exchange Commission (CVM), and have to abide by mark to market procedures set by these bodies Insurance company managers are satisfied with these investment regulations and believe that they conform to the conservative view the great majority of Brazilians adopt regarding their savings Supervisory Structure The main issue in relation to supervision is the question of the single regulator for the complementary pension system This is quite controversial, as the recent UK experience shows (Davis 2002; Pickering 2002; DWP 2002a and 232 Retirement provision in scary markets 2002b) It is not clear whether the differences between employer-provided occupational pension plans and personal pension plans provided by insurance companies justify the existence of separate regulators If this were changed to a single regulator, there would still remain the issue of under which Ministry this body should be subordinated: Social Security or Finance Presently there is not enough evidence to clearly work out what the best arrangement is Brazilian policy makers need to analyse with greater care the experience of countries – such as Sweden and Australia – which opted for a single regulator PRIVATE PENSION COSTS The Open Pension System Since traditional plans are no longer offered, this discussion will concentrate on the PGBLs and VGBLs The first thing to be noted is that stiff competition in this market, especially the desire of new entrants to capture market share, has led to a strong fall in fees Three types of fees may be charged: a fee on contributions; a fee for investment management charged as a percentage of the fund’s assets, and, more recently, a fee on withdrawals and transfers The last is probably charged to recover the impacts of CPMF taxation (0.38 per cent of the value of transferred funds from the account where the funds were held) As expected, the charging policy differs between individual and collective open plans Charges on contributions and on transfers or withdrawals must be outlined in the plan’s prospectus Since all PGBLs and VGBLs must invest in publicly quoted mutual funds (FIFs), the investment management fee is reported in the major newspapers, making this a very transparent charging structure In 2001, SUSEP conducted a study on fees charged by individual PGBLs Fees on contributions varied from per cent to per cent and investment management fees from 2.5 per cent to 3.5 per cent In many individual plans the value of the fees on contributions falls according to the value of the accumulated reserves and period of participation SUSEP believes that investment management fees may fall with the increase of total assets in these funds and with the forthcoming rule changes allowing PGBLs and VGBLs to invest directly in an FAC.8 For the collective open plans, it is common practice for insurance companies to waive the fee on contributions for medium to large sponsors The maximum investment management fee that providers have been able to charge recently is around 1.5 per cent to 1.8 per cent This is somewhat higher for the smaller sponsors The average fees are reported to be around 1.5 per cent to per cent, although there are a few collective plans charging less than per 233 The Brazilian private pension system cent Table 11.8 takes a look at the reported investment management fees of all PGBL funds It does not distinguish, however, funds that receive investments from collective and individual plans These fees can be considered low when compared to those practised by 401(k) providers in the USA In addition, it is worth noting that these asset management fees are not very different from those charged by fixed income mutual funds for investments under R$50 000 A comparison of these fees with those levied in the compulsory individual account systems introduced in a number of other Latin American countries is not simple given the different charging structures In Chile, Argentina, Peru, Bolivia, Colombia, El Salvador and Mexico, individual account providers use a front-loaded fee on contributions In Brazil, however, although there is a fee on contributions, the major cost component is the asset management fee The comparison therefore requires the conversion of these different structures to an equivalent asset management fee James et al (2001) undertake this exercise based on the Chilean case Based on an average level of a 15.6 per cent fee on contributions, they show that the equivalent asset-based fee could vary from 0.45 per cent to 33.37 per cent, depending on workers’ working and contribution history The longer the worker stays in the system, the smaller will be the equivalent asset management fee Their guess is that an average annual expense would be 0.94 per cent Bravo (2001), however, states that the contribution fee for the same period is around 21 per cent of contributions (after deducting that part of the fee earmarked for survivors’ and disability insurance) He estimates that for workers who have contributed for less than 15 years, the management fees are above per cent of their funds Table 11.8 Asset management fees of PGBL funds Asset management fee (%) PGBL fixed income No Below 1.00 From 1.01 to 1.50 From 1.51 to 2.00 From 2.01 to 2.50 From 2.51 to 3.00 From 3.01 to 3.50 From 3.51 to 4.00 Total Source: % 0.0 6.8 34 38.6 25 28.4 9.1 12 13.6 3.4 0.0 88 100.0 Gazeta Mercantil (7–8 December 2002) PGBL sovereign No % 2 0 0 40 40 20 0 0 100 PGBL mixed No % 0.9 0.9 15 12.8 46 39.3 29 24.8 22 18.8 1.7 0.9 117 100.0 234 Retirement provision in scary markets Whatever the correct assumption, it seems that fees charged in the Brazilian open fund market compare favourably with those of Chile Furthermore, given that the Brazilian system is voluntary, and the contribution period may be shorter, an asset management fee would be much more favourable to the consumer It must also be noted that competition in this market is much more vigorous in Brazil than in any of the comparator countries This may lead to greater fee reductions in the future TAXATION OF PRIVATE PENSIONS Since 1983, the EFPCs had been battling the Brazilian Income Revenue Service (SRF) in the courts on the issue of tax immunity for closed pension funds The SRF wanted to tax closed pensions during the accumulation phase This was rather confusing, since it had already granted, in 1995, tax deferral for contributions and investment returns of open pension funds This issue was finally resolved in 2002 with the decision that all funded pension schemes would have their investment returns taxed at the normal income tax rate of 20 per cent They were, however, granted the option to adhere to a special taxation regime (the RET) that sets a limit to the amount of this tax Pension plans, open and closed, that opt for RET will pay an income tax limited to the product of employer contributions and the difference between the sum of income tax and net profit social contribution (CSLL) rates, and 80 per cent of the maximum marginal tax rate for individuals Since the former is equal to 34 per cent and the latter to 22 per cent, the maximum tax paid under RET is 12 per cent of employer contributions to the plan Simulations suggest that the impact of this tax is about to per cent of the balance of a defined contribution account, given equal employer and employee contributions over a 35-year period.9 To opt for RET, however, the pension funds had to cease all litigation with the SRF regarding taxes and pay the due amounts (with a pardon for interest and penalties) This condition affected only the closed pension funds It is estimated that as a result of this measure, the government collected around R$9 billion by September 2002 Although the impact of the RET regime does not seem to be very significant, it maintains the fear of instability in the tax treatment of private pensions It must be remembered that the 12 per cent on employer contributions rule may be automatically changed if marginal rates for corporate and individual income are modified It would certainly assist the further development of funded pensions in Brazil if the government granted full tax deferral, as is the practice in most OECD countries It is estimated that R$700 million are collected annually as a result of this tax The Brazilian private pension system 235 The greatest tax burden now for funded schemes is the Financial Transactions Provisional Contribution (CPMF) This tax commenced in 1998 as a transitory tax to help finance investments in health It is charged on every financial transaction at a rate of 0.38 per cent Every time money is withdrawn from an account, this tax is charged When a pension fund sells a security to purchase another, it must pay CPMF It can be argued that, just like banks, pension funds should be exempt from CPMF when they are investing assets which guarantee the benefit plan Contributions made by the employer to the pension fund should also be exempt from CPMF Another issue is the taxation of VGBL plans Although modelled on the Roth IRA (offered in the USA), VGBLs have a less generous tax treatment, since the portion of the final account balance corresponding to accrued earnings is taxed when distributed A solution would be to specify the concept of qualified distributions: those withdrawn after a minimum period of time (such as five years, as in the USA) since the contribution was made and when the participant has reached a minimum age (such as 59½ years, as in the USA) Such distributions would then be subject to no income tax CONCLUSION It seems very likely that future pension reforms in Brazil will follow the path of the USA and the UK instead of that of other Latin American countries This would imply a gradual reduction of the importance of the public pension system and increasing reliance on the private pension system as a source of retirement income Presently the coverage of the private system is small, although personal pension plans have been growing at an impressive rate since 1995 Coverage of occupational pensions, however, has remained stagnant The government therefore must direct its policies in this area to maintain the growth of personal pensions and foster a new growth phase for occupational pensions On the basis of the US and UK experience, Brazilian authorities should seriously consider if current tax incentives are sufficient to foster the expansion of private pension coverage Recent developments have gone in the opposite direction It appears that in seeking greater participant protection and attempting to curtail abuses of tax incentives, regulatory authorities in many countries have construed a regulatory framework that is far too complicated and imposes undue costs on private pension providers Unfortunately, this is exactly what has happened in Brazil in regard to occupational pension funds (closed funds) There is the great risk of ‘devaluing the regulatory currency’ The occupational system clearly demands a new regulatory approach based on appropriate risk evaluation models and cost–benefit analysis 236 Retirement provision in scary markets NOTES The author would like to thank the following persons for their collaboration with this report: Luiz Peregrino and Beatriz (SUSEP), Eduardo Bom Ângelo (ex-President of Cigna); Fuad Noman Filho (ex-President of ANAPP and Brasilprev); Osvaldo Nascimento (President of ANAPP and Itaúprevidência); Paulo Ferreira (Tillinghast); Devanir da Silva (Superintendent, ABRAPP); Ana Carolina (Mattos Filho Lawyers); Ricardo Weiss (BNDES); Edson Jardim (W.M Mercer) and Newton Conde (Watson Wyatt) RGPS is the public pension system that covers the working population with the exception of public employees (including the military) The latter have their own public pension system (the RPPS) The VGBL is classified as a life insurance product for tax purposes The Roth IRA has a much more favourable tax treatment as there is no taxation on benefits There is always the risk in the case of the VGBL of taxing inflationary gains, which, depending on inflation, may significantly hinder the performance of these plans The law allows the investment of VGBL plan assets in the same mutual funds (FIFs) used by PGBL plans This is exactly what providers are doing in order to benefit from scale economies and reduce the incidence of the financial transactions tax (CPMF) Throughout this chapter all values will be expressed in reals, since strong fluctuations in the exchange rate may distort the analysis Non-operational assets are those that are not given as a guarantee to the reserves of benefit plans and non-operational liabilities are those not related to the payment of plan benefits (they correspond to labour and tax liabilities) AFAC is a mutual fund that invests in quotes of other mutual funds (FIFs) This measure, which is still pending regulation, will lead to fewer expenses with the financial transactions tax (CPMF) Simulations by the author and Watson Wyatt Brazil REFERENCES Bravo, J (2001), ‘The Chilean pension system: A review of some remaining difficulties after 20 years of reform’, paper presented at the International Seminar on Pensions, Hitotsubashi University, Tokyo, Japan Davis, B (2002), Report of the Quinquennial Review of the Occupational Pensions Regulatory Authority (OPRA), Department for Work and Pensions (DWP), London, UK Department of Work and Pensions (DWP) (2002a), Simplicity, Security and Choice: Working and Saving for Retirement, presented to Parliament by the Secretary of State for Work and Pensions, London, UK Department of Work and Pensions (DWP) (2002b), Simplicity, Security and Choice: Technical Paper, London, UK James, E., J Smalhout and D Vittas (2001), ‘Administrative costs and the organization of individual account systems: A comparative perspective’, World Bank Policy Research Paper No 2554, Washington, DC, USA Pickering, A (2002), A Simpler Way to Better Pension: An Independent Report, Department of Work and Pensions, London, UK World Bank (2001), Brazil: Critical Issues in Social Security, Washington, DC Index accounting standards, for pension funds 46, 192–3, 208–9 active investment management 55, 64, 66–7 actuarial values, and pension smoothing 149–50, 158 age and annuity purchase 140–42 and lifetime earnings 81, 82, 84–5, 86 old-age dependency ratios and retirement decisions 115, 116, 118 and retirement wealth 88, 89, 93 and savings decline 112, 118 age pension (Australia), and risk tolerance 138–9 ageing economic effects 3, see also retirement income/wealth allocated pensions advantages and disadvantages 33–4, 125 income streams 125–7 portfolio mix 127, 139 sales 127–9 annuities decline in rates 101, 102–3 optimal purchase age 140–42 provision in Brazil 221 see also life expectancy annuities; lifetime annuities; term annuities Ansett Ground Staff Superannuation Plan contribution levels 168–9, 173–4, 176 court case 174–80 effect of Ansett’s collapse 161–2 fund status 169–70, 171, 172 minimum requisite benefits 164, 168 priority over other debtors 176–9 retrenchment benefits 166, 168, 170, 171–4, 175–6, 179–80 winding up 179–80 anti-selection 149, 150, 153–4 APRA see Australian Prudential Regulatory Authority assets classes of 57–60 management 195, 196, 202 pricing 225, 227 see also portfolios ASX 200, volatility of 18, 20, 22 Australia age pension, and risk tolerance 138–9 asset classes 57–8 bond market 52, 59 economic situation 3, equities benchmark index 60 returns 30–32, 59, 61, 101, 102, 103 volatility of 18, 20, 22–9, 59, 62 government borrowing 47, 48 listed property trusts returns on 31, 59, 61 volatility of 17, 18, 20, 22, 27, 59, 62 pension sales 127–9 property returns on 30–31, 59, 61 volatility of 27–9, 59, 62 Superannuation Guarantee 163 superannuation legislation history 162–3 and insolvency 167–8, 183–4 minimum funding standards 163–7, 182–3 see also Ansett Australian Prudential Regulatory Authority, role 164, 165 average weekly earnings, changes in 59, 61–2 237 238 Retirement provision in scary markets banking, in Brazil 220 benchmark indexes 56–7, 58, 60 changes in 70–71, 72 exclusivity in 72 benchmark indexes 500 see also ASX 200; FTSE; S&P benefit rights, protection 201–2, 203 bonds benchmark index 60 corporate 48, 49–52 government 47–8 and pension funds 45–9 portfolio management 52–3 returns on 59, 61, 101, 103–4 volatility of 59, 62 bonuses, smoothing 149–50 Brazil economic situation 3, financial service industry 220–21 private pension system annuity provision 221 asset pricing 225, 227 closed pension plans 211–16, 218, 224–5, 227–30, 234–5 fees 232–4 funding levels 215, 219, 224–6 insolvency regulations 226 interest rates 218, 222, 224–5 investment regulations 227–31 open pension plans 211, 216–17, 218–22, 223, 225–7, 231, 232–5 regulation 222, 224–32 statistics 213, 214, 215, 220, 221, 222, 223 structure 211–12, 216–17 supervisory structure 231–2 taxation 234–5 cash benchmark index 60 returns on 59, 61 volatility of 62 cash balance pension plans, Japan 197, 203 Chile, pension plans, fees 233 closed pension plans, Brazil 211–16, 218, 224–5, 227–30, 234–5 constant proportion portfolio insurance 133 constant relative risk aversion model 129, 131–3, 135–6, 137, 138, 140 consumer price index 3, 4, 59, 61–2 contracting out 189, 191, 193, 200 corporate bonds 48, 49–52 corporate governance, and index funds 73 counterparties, for forward contracts 151, 152, 155 credit management and bonds 49–52 macro/micro 52–3 crediting rates, delay in changing 149 cross subsidies, in DB pension schemes 146–7 CRRA see constant relative risk aversion model defensive assets 58 see also bonds defined benefit pension funds inequities in 146–7, 166–7 investment in bonds 46–7 Japan see Japan, defined benefit pension plans minimum requisite benefits 163–4, 182–3 risk management 146 shortfalls 45–6, 181, 182–4 see also Ansett see also Australia, superannuation legislation; cash balance pension plans defined benefit pensions, and retirement decisions 113, 115, 117 defined contribution pensions benefits 147 Brazil see Brazil, private pension system Japan 198, 199, 203, 204 minimum requisite benefits 163 and retirement decisions 113, 115, 117, 118 risk management 146, 148 smoothing see smoothing see also cash balance pension plans demographic trends 3, 6, 187 dependency ratios direct property see property Index dividend indexes, for forward contracts 155–8 dividend reinvestment plans 65 dividends, and index funds 70 divorce, and lifetime earnings 84–5, 86 earnings, benchmark index 60 earnings variability 59, 61–2 and earnings levels 95 factors in 80, 81–2, 84–5, 86 lifetime hypotheses 86–8 and retirement wealth 86–7, 88–94 measures 95–6 research methodology 82–6 statistics 80–82, 83 economies of scale, in index funds 72–3 education and lifetime earnings 84–5, 86 and retirement decisions 116, 118 and savings decline 110, 111, 112, 118 Employee Pension Funds (Japan) 189–90, 191, 193, 198, 199 benefit rights protection 201–2, 203 and contracting out 189, 191, 193, 200 design changes 200, 203–4 funding rules 202–3, 204–5 returns on assets 192 terminations 191, 205 Employees’ Pension Insurance (Japan) 188, 189 employment see earnings; labour relations; retirement flexibility; return to work; unemployment enhanced index funds 64–5 equities decline in (1999–2001) 101, 102, 103–4 and retirement decisions 104–5 for retirement income 29, 33–4, 37–43, 101 and retirement flexibility 104 returns on 30–32, 59, 61, 101, 102, 103 volatility of 16–17, 62 Australia 18, 20, 22–9, 59, 62 industry-level 25, 26 239 international 17, 19, 21, 27, 29, 59, 62 length of bad runs 27–9 US 22, 24, 26 see also benchmark indexes; share prices equity premium, in pension schemes 146, 147–8, 154 ethics see social responsibility ethnicity, and lifetime earnings 84–5, 86 Europe corporate bonds 49 equities, returns 101, 102, 103 government borrowing 48 see also United Kingdom exchange-traded funds 56, 65–6 fees for pension plans 232–4 see also transaction costs females see sex FIFs see mutual funds financial engineering, definition 123–4 financial services, in Brazil 220–21 Financial Transactions Provisional Contribution (Brazil) 235 financial wealth measures 96 and retirement decisions 105 and retirement wealth 86–8, 89, 90, 92, 93, 94 see also cash; savings flexible retirement see retirement flexibility forward contracts, for pension smoothing 151–8 France, government borrowing 48 Free Benefit Generator Life Plan (VGBL) (Brazil) 217, 218, 220–22, 226, 231, 232, 235 Free Benefit Generator Plan (PGBL) (Brazil) 216, 218, 220–22, 223, 226, 231, 232–4 FTSE All-Share Index 101 funding levels for pension funds 193–4, 215, 219, 224–6 see also minimum funding 240 Retirement provision in scary markets funding rules for pension plans 193, 202–3, 204–5, 208 see also minimum funding gender see sex Germany, government borrowing 48 governance see corporate governance; regulation government borrowing 47, 48 see also bonds gross domestic product 3, Ground Staff Superannuation Fund see Ansett Ground Staff Superannuation Plan growth assets 57–8 see also equities guarantee funds, for pension shortfalls 184 HARA see hyperbolic absolute risk aversion model health, and lifetime earnings 84–5, 86 Health and Retirement Study (US) 79–80, 83, 84–5, 88, 105 housing wealth and earnings variability 90, 92, 93, 94 measures 96 and savings decline 112 statistics 89 hyperbolic absolute risk aversion model 129–30, 132–3, 135–6, 137–8, 140–41 immunization 46 index funds and benchmark index strategies 70–71, 72 benefits 66–7 characteristics 55–7, 64 and corporate governance 73 and dividends 70 and economies of scale 72–3 enhanced 64–5 and index volatility 69–70 and social responsibility 74 strategies 67–8, 71–2, 73–4 tracking error management 67–73 transaction costs 69 see also benchmark indexes; exchange-traded funds indexes, for forward contracts 155–6 industry-level equities, volatility of 25, 26 inflation see consumer price index inflation-linked assets, for pensions 155 insolvency of Ansett Ground Staff Superannuation Plan 179–80 regulations Australia 167–8, 183–4 Brazil 226 see also insurance; solvency insurance pension insurance (Japan) 188 for pension shortfalls 184 portfolio insurance 133 for termination of pension plans 202, 205 see also benefit rights, protection interest rates Brazil, pension plans 218, 222, 224–5 for cash balance pension plans 197 for forward contracts 152, 155 UK 4, 46 international equities benchmark index 60 returns 31–2, 59, 61, 101 volatility of 17, 19, 21, 27, 29, 59, 62 investment funds see exchange-traded funds; managed funds investment guarantees, and pension smoothing 158 investment regulations, for pension schemes 227–31 investment strategies see active investment management; lifestyle investing; portfolios Japan cash balance pension plans 197, 203 corporate bonds 49 defined benefit pension plans 188–9 asset management 195, 196, 202 benefit design changes 197–201, 203–4 benefit reductions 191, 195, 197, 201, 203 Index benefits rights protection 201–2, 203 and contracting out 189, 191, 193, 200 funding levels 193–4 funding rules 202–3, 204–5, 208 regulation 189–90, 192–3, 201–3, 208–9 returns on assets 192 risk management strategies 206–8 statistics 190, 191 terminations 191, 198, 200, 202, 205 defined contribution pension plans 198, 199, 203, 204 economic situation 3, 4–5, 187, 192 government borrowing 48 pension insurance 188, 189 public pensions 188 severance payments 188–9, 190, 192–3 see also Employee Pension Funds; tax qualified pension plan labour market see retirement decisions; return to work; unemployment labour relations, and pension benefit design changes (Japan) 201 ‘last man out’ problem, and retrenchment funds 166–7, 180 life expectancy, and investment decisions 33 life expectancy annuities 125, 127, 128 lifestyle investing 148–9, 154, 155 see also portfolios (for retirement) lifetime annuities advantages and disadvantages 33, 124–5 declining purchases of 127, 128, 139–40 lifetime earnings see earnings variability, lifetime listed property trusts (Australia) returns 31, 59, 61 volatility of 17, 18, 20, 22, 27, 59, 62 longevity see life expectancy macro/micro credit management 52–3 males see sex managed funds 63–5 241 market frictions, in index fund management 68–9 marriage and pension wealth 87, 89–94 and retirement decisions 116 and savings decline 112 minimum benefits index, for insolvent pension funds 179–80 minimum funding for pension funds 163–7, 181–3, 189–90 see also funding levels minimum requisite benefits Ansett Ground Staff Superannuation Plan 164, 168 for pension funds 163–4, 182–3 Morgan Stanley Capital International, volatility of equities 19, 21 multi-sponsored occupational pension plans 213–14 mutual funds, Brazil 231 National Pension Insurance (Japan) 188 occupation and retirement decisions 115, 116, 118 and savings decline 110, 111, 112, 118 occupational pension plans see closed pension plans old-age dependency ratios open pension plans, Brazil 211, 216–17, 218–22, 223, 225–7, 231, 232–5 optimization, in index fund management 68 passive investment management see index funds Pension Benefit Guaranty Corporation (US) 184 pension funds accounting standards 46, 192–3, 208–9 fees 232–4 funding levels 193–4, 215, 219, 224–6 insolvency see insolvency minimum funding 163–7, 181–3, 189–90 242 Retirement provision in scary markets regulation see regulation of pension plans risk management in 145–6, 148, 206–8 structures 63–6, 211–12, 216–17 and taxation 33, 234–5 see also defined benefit pension funds; index funds; trustees pension wealth and lifetime earnings 87, 90, 91, 93, 94 and marriage 87, 89–94 measures 96 statistics 89 see also social security wealth pensioners see retirees pensions sales Australia 127–9 Brazil 220, 221, 222, 223 smoothing see smoothing of pensions see also age pension; annuities; benefit rights; private pensions; public pensions; retirement income; social security wealth PGBL see Free Benefit Generator Plan portfolio insurance 133 managed 63–6 portfolios (for pension schemes) Brazil 227–31 Japan 195, 196, 202 see also active investment management; assets; bonds; equities; index funds portfolios (for retirement) choice of 14–15, 32, 124–9 with equities 29, 33–4, 37–43, 101 and life expectancy 33 and risk tolerance 129–30, 134, 138–9 scenarios 34–7 outcomes 37–43 simulation profile 134–5 simulation results 135–9 simulation theory 129–33 without equities 30–32, 38, 39, 40–42 see also allocated pensions; annuities; bonds; cash; equities; lifestyle investing; private pensions; savings private pensions development of 1–2 regulatory structure 5–6 and retirement decisions 113, 115, 117, 118 and savings decline 110–11, 117, 118 statistics 106 vulnerability factors 2–6 see also allocated pensions; annuities; Brazil, private pension system; cash balance pension plans; defined benefit pensions; defined contribution pensions property benchmark index 60 returns on 30–31, 59, 61 volatility of 27–9, 59, 62 public pensions Japan 188 see also age pension redundancies see retrenchment regulation of pension plans Brazil 222, 224–32 funding rules 193, 202–3, 204–5, 208 Japan 189–90, 192–3, 201–3, 208–9 structure 5–6 residential property see property retirees, characteristics 32–3 retirement decisions and equities 104–5 factors in 105, 111, 115–17, 118 and private pensions 113, 115, 117, 118 and retirement flexibility 112, 115, 116 and savings decline 110, 111, 112, 113–19 survey methodology 106–7 see also return to work retirement flexibility and investment in equities 104 and retirement decisions 112, 115, 116 retirement income/wealth and earnings variability 88–94 hypotheses 86–8 Index effects of equity and annuity market declines 103–4 factors in 79–80 measures 96–7 portfolios see portfolios smoothing see smoothing statistics 88, 89, 90, 106 trends 1–2 see also annuities; financial wealth; housing wealth; pension wealth; portfolios; savings retrenchment benefits Ansett Ground Staff Superannuation Plan 166, 168, 170, 171–4, 175–6, 179–80 pension funds standards 166–7 see also severance payments return to work decisions, and savings decline 117, 119 risk management, in pension funds 145–6, 148, 206–8 risk tolerance and portfolio selection 129–30, 134, 138–9 see also constant relative risk aversion model; hyperbolic absolute risk aversion model S&P 500 19, 21, 101 savings decline 107–11 and retirement decisions 110, 111, 112, 113–19 severance payments Japan 188–9, 190, 192–3 see also retrenchment sex and annuity purchases 142 and annuity rates 102 and lifetime earnings 80, 81–2, 84–5, 86 and retirement decisions 116, 118 and savings decline 110, 112, 118 share prices 3, 4–5, see also equities, returns shortfalls of defined benefit pension funds 45–6, 181, 182–4 insurance 184, 205 see also Ansett Ground Staff Superannuation Plan; 243 insolvency smoothing of pensions current methods 148–51 through forward contracts 151–6 applications 158–9 and investment guarantees 158 South African example 156–8 social responsibility, and index funds 74 social security wealth and earnings variability 86–7, 88–9, 90, 91, 93, 94 measures 96–7 see also age pension; public pensions socioeconomic status and lifetime earnings 84–5, 86 and retirement decisions 116, 117 and savings decline 110, 112 solvency for pension funds, definition 163–4 see also insolvency South Africa, pension smoothing, example 156–8 sovereign debt see government borrowing spiders (SPDRs) 65 Standard & Poor see S&P stochastic lifestyling 148–9 stock market see equities; share prices stratified sampling, in index management 68 superannuation funds see defined benefit pension funds legislation see Australia, superannuation legislation Superannuation Guarantee (Australia) 163 supervisory structure, for pension plans, Brazil 231–2 tax qualified pension plan (Japan) 189, 190, 191, 198, 199 benefits rights protection 201–2, 203 design changes 204 funding rule changes 202 taxation, and pension plans 33, 234–5 term annuities 125, 127, 128 termination of pension plans Japan 191, 198, 200, 202, 205 see also insolvency 244 Retirement provision in scary markets tracking error management, in index funds 67–73 transaction costs of index funds 69 see also fees trustees, roles 55, 63 unemployment, statistics United Kingdom corporate bonds 49 economic situation 4, 5, 46 equities, returns 101, 102, 103 government borrowing 48 pension funds accounting rules 209 minimum funding requirement 181–2 United States corporate bonds 49 economic situation 4, equities returns 101, 102, 103 volatility of 22, 24, 26 government borrowing 48 Health and Retirement Study 79–80, 83, 84–5, 88, 105 Pension Benefit Guaranty Corporation 184 very-old persons dependency ratios vested benefits standard, in pension funds 164–6, 182 VGBL see Free Benefit Generator Life Plan Watson Wyatt survey 106–11 web-based surveys, limitations 107 widowhood, and lifetime earnings 84–5, 86 winding up see insolvency women see sex ... Library of Congress Cataloguing -in- Publication Data Retirement provision in scary markets / [edited by] Hazel Bateman p cm Retirement provision in scary markets : introduction / Hazel Bateman... Voluntary participation in private Retirement provision in scary markets pensions increased in the UK with the introduction of ‘contracting out’ in the mid-1980s, whereby many defined benefit public... permanent increase Investing in equities for retirement 17 in equity markets volatility We then investigate Australian equity market volatility in more detail by decomposing it into market-level, industry-specific